When a business owner falls behind on the mortgage payments for an office building or retail center, the commercial lender will begin foreclosure proceedings to recover the property and satisfy the debt. Commercial foreclosures proceed in much the same way as residential foreclosures, however, some significant differences exist. For instance, if the borrower is an absentee property owner, or is inattentive to the needs of the business, the lender might ask the court to protect the investment by appointing a third-party “receiver” to manage the business during the foreclosure.
Commercial Foreclosure Procedures
The laws of the state where the property is located determine whether the lender can use a streamlined nonjudicial foreclosure process or whether the foreclosure must proceed through the state court system.
In a nonjudicial foreclosure, the lender must follow steps outlined in statutory law before selling the property at auction. For example, in California, the nonjudicial foreclosure process starts when the lender provides the borrower with a notice of default letter. Ninety days must elapse before the lender can give the borrower notice of the sale date. The lender must allow the borrower to bring the loan current, as well. Once the procedural steps are complete, the lender can sell the property at a foreclosure sale. (You can find out how loan documents affect the foreclosure process in Understanding Foreclosure: Your Loan and Foreclosure Documents Hold the Answers.)
A judicial foreclosure begins when the lender initiates a lawsuit by filing a complaint or petition with the court. If the bank receives a foreclosure judgment, the property is sold to repay the outstanding mortgage debt. (To learn more about judicial and nonjudicial foreclosures, see What’s the Difference Between Judicial and Nonjudicial Foreclosures?)
The Role of the Receiver During Foreclosure
During a foreclosure, the property owner is entitled to remain in possession of the business as long as the owner preserves the value of the asset securing the lender’s investment. If, however, the borrower allows the property to decline, or fails to abide by contract provisions in the loan documents, the lender can ask the court to appoint a receiver as part of the judicial foreclosure. (If the bank chose to proceed with a nonjudicial foreclosure, the lender could request relief in a separate lawsuit.)
For instance, a bank will typically include a contract provision entitling the bank to receive tenant rents in the event of default—and it makes sense. If a business is failing, an owner might pocket the rents instead of turning it over to the bank. A receiver can collect the rents, as well as ensure that the property remains attractive to buyers by filling tenant vacancies and promptly responding to maintenance issues.
If the court grants the lender’s request, the receiver will manage the business property until the foreclosure sale. The lender can ask for other relief, as well. For instance, the court might allow the receiver to sell the property before the foreclosure is complete as long as the lender, borrower, and any junior lienholders agree.
How to Avoid Foreclosure
All parties involved in a foreclosure feel its effects. Most banks are willing to lessen the adverse effects on the borrower by considering the following foreclosure alternatives:
- offering the borrower a repayment plan (the borrower makes up missed payments over time)
- suggesting a mortgage modification (change in loan terms)
- agreeing to a short sale (a sale for less than the amount owed on the loan), or
- accepting a deed in lieu of foreclosure (the borrower legally returns the property to the lender).
When borrowers can’t successfully arrange for an alternative to foreclosure, they might still be able to raise one or more defenses to fight the foreclosure. For example, you may be able to argue that:
- the lender didn’t follow the proper foreclosure procedures under state law
- the lender didn’t provide notice as required by the mortgage contract, or
- the mortgage servicer made mistakes or errors in its handling of the loan account.
You can find out more about foreclosure alternatives by reading How to Avoid Commercial Foreclosure.
The Foreclosure Sale
At the foreclosure sale, the lender will make a “credit bid,” which means that the bank won’t come up with actual money. Instead, the bank will get credit for the total amount of the debt owed by the borrower (including the principal, interest, late fees, attorneys’ fees, and foreclosure costs). The lender uses the credit to bid at the foreclosure sale. If no third party bids higher than the lender’s credit bid, the lender becomes the new owner of the commercial property. On the other hand, if a third-party outbids the lender, the third-party becomes the new owner of the property, and the sale proceeds are used to repay the mortgage obligation.
Hiring an Attorney
Figuring out your best response to a looming foreclosure calls out for a professional’s analysis of your situation. Depending upon the provisions in your loan documents, you might stand to lose more than the foreclosed property. A lender can often satisfy the outstanding debt by using collection tools. For example, you might have “cross-collateralized” the loan by pledging additional property as security. Your loan documents might include a clause that allows the lender to recoup losses by repossessing fixtures and goods owned by your business. You also might have signed a “personal guarantee” that allows the lender to satisfy any outstanding debt by proceeding against your home, bank accounts, and other personal assets. (For more information about how a creditor can collect from you, see Common Ways Lenders Secure Commercial Loans.)
If you’re not sure about the extent of your lender’s rights, you should consult with a qualified attorney who can review your loan documents and advise you of your options.
Questions for Your Attorney
- Will the foreclosure be judicial or nonjudicial?
- Is it likely that the lender will ask for a receiver in my case?
- Will you help me negotiate an alternative to foreclosure?
- Do any foreclosure defenses apply to my situation?